Hedge Fund vs Mutual Fund: Where Should You Invest In 2023?
Hedge funds are private investments that are available only to investors with high net worth. On the other hand, mutual fund schemes are regulated investment instruments that are available to the general public and can be traded daily.
But which of the two is a better option?
To understand the same, let’s dive into hedge fund vs mutual fund and other crucial aspects such as investment strategy and associated fees in detail below.
What are Mutual Funds?
Mutual funds are an investment vehicle that collects money from investors to allocate it to financial securities. The invested amount is managed by professional fund managers, who buy and sell assets to achieve a predetermined financial objective.
Such an objective can be either focused on generating high returns or preserving invested capital. This option is suitable for investors looking to invest in different asset classes without the hassle of picking individual securities or the monetary burden of the same.
Mutual funds offer units to investors allotted based on their investment amount and a scheme’s NAV. For instance, if a scheme’s NAV is Rs. 50 and you invest Rs. 2000, you’ll receive 40 units of that mutual fund.
Later, you can sell the units fully or partly to realize capital gains or losses based on that day’s NAV. Thus, the extent of profits or losses on mutual funds will depend on the amount they choose to allocate to a scheme.
What are Hedge Funds?
In the world of finance, hedging means safeguarding against risks. Hedging is a strategy to use specific securities to counter the losses generated by other assets.
Hedge funds are an investment vehicle that utilizes advanced strategies to invest in complex products, including derivatives such as futures and options. They collect funds from accredited investors including High-Net-Worth Individuals (HNIs), banks, and insurance companies.
Their portfolio consists of currencies, derivatives, and more. The primary aim of hedge funds is to maximize the returns of investors while eliminating risk.
Also Read – Difference Between SIP And Mutual Funds
Hedge Fund vs Mutual Fund
Investment strategy
Hedge fund managers typically adopt more aggressive investment strategies. In the case of mutual funds, investment strategies vary across schemes. For example, a debt mutual fund manager will undertake conservative investment strategies to prevent losses. In contrast, an equity mutual fund manager will use bolder tactics to generate maximum profits for investors.
Typically, hedge funds aim to generate positive returns for investors, irrespective of the market scenario. Accordingly, they make high-risk moves and are riskier than mutual funds. Therefore, a hedge fund can also generate greater profits.
Who can invest?
Contrary to mutual funds, only accredited investors such as institutional investors and HNIs can invest in hedge funds.
The minimum investment amount in hedge funds is Rs. 1 crore, which is significantly higher than that of mutual funds. However, on the flip side, one can start investing in mutual funds via a systematic investment plan (SIP) with as low as Rs. 500 per month.
The expense ratio and tax liability are also more for hedge funds. Accordingly, hedge funds are suitable for only those who are financially well-positioned and have a high-risk appetite. However, mutual funds are accessible to everyone looking to invest in the market.
Also Read- How To Invest In Multi-Cap Mutual Funds?
Associated fees
The fees associated with hedge funds are of two types – expense ratio and performance fees.
Expense ratio is the charge hedge funds levy on investors annually to cover the operating expenses, whereas the performance fee is deducted from the profits that investors earn. Usually, the expense ratio in hedge funds is around 2%, whereas the performance fee is roughly 20%.
Note that the fees vary from one hedge fund to another.
In the case of mutual funds, there are three types of fees – expense ratio, exit load, and entry load.
Entry load is a fee that fund houses charge investors when they buy units of a scheme. Exit load is a cost that Asset Management Companies (AMCs) levy if investors sell a scheme’s units before a specific date.
The fees associated with mutual funds differ across funds. Nonetheless, the expense ratio for mutual funds is capped at 2.25% by the Securities and Exchange Board of India (SEBI), and for index funds such as the Navi Nifty 50 index fund, it’s as low as 0.06%.
Moreover, there is no entry or exit load associated with this fund. To reap the benefits of investing in the fund, head over to Navi Mutual Fund now.
Holding period
Hedge funds have low liquidity when compared to mutual funds because of the accompanying lock-in period during which investors cannot withdraw their investments. Notably, most mutual fund schemes can be easily exited with the exception of a few fund schemes such as ELSS.
National regulations
For mutual funds in India, it is compulsory to adhere to the Securities and Exchange Board of India. However, hedge funds do not have to register themselves with the securities market regulator.
Final Word
Investing is not easy, especially considering the various complexities of each type of investment avenue. That said, once investors have a clear idea of the distinguishing factors regarding hedge funds vs mutual funds, they must choose an option in line with their financial goals.
Frequently Asked Questions
Who can invest in hedge funds?
Hedge funds are available only to those investors who have a high net worth and can shoulder high-risk levels.
Hedge funds do not need to report their net asset value every day, unlike mutual funds.
What is the minimum amount needed to start a hedge fund in India?
The minimum amount of investment to start a hedge fund is Rs.20 crores in India.
Can individuals invest in hedge funds via SIP?
No, investors cannot allocate their money to hedge funds via a SIP.
What is the lock-in period in hedge funds?
Hedge funds come with a lock-in period of 12 months. Strict restrictions are imposed on the withdrawal of funds. For instance, depending on the scheme, investors can withdraw funds either quarterly or bi-monthly.
Glossary
| Future is a contract comprising two parties – buyer and seller – where they agree to buy and sell an underlying security, usually stocks, on a future date at a fixed price. Both the buyer and seller must carry out the specified transaction according to the contract. |
| Option is a contract that offers an investor the right to buy or sell an underlying security, such as shares, within a specific window at a prespecified price. |
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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
